The mood in markets is more tense than ever. Within minutes yesterday afternoon shares in London veered wildly from more than a per cent into positive territory to drop to their lowest level in five years.

By Edmund Conway, Economics Editor

5:27PM BST 16 Oct 2008

Every snippet of news on both the economy and the financial system has the power to send share prices flying or tumbling. Having prematurely declared an end to the financial crisis, markets are once again back on edge. Yesterday it was dismal news about the state of the US manufacturing sector. Who knows what news it will be tomorrow?

The wild turbulence has sparked fears that the £2 trillion injection into financial markets by governments around the world has been wasted.

As share prices fall and experts warn that a host of economies are now heading for recession, the rate of borrowing in the City's wholesale borrowing markets remains lodged at torrid levels.

These money markets are the very epicentre of the current crisis. That the rates have shot up reflects the fact that banks simply will not lend to each other. Until the markets recover, one cannot declare an end to the crisis. And despite great hopes that the bail-outs in the UK, Europe and the US would bring down interbank borrowing rates, they have dropped only marginally this week.

Not only does this mean mortgage customers may not benefit so quickly from the Bank of England's half percentage point rate cut last week, it also has dire consequences for businesses throughout the world. Given that almost every single interest rate in the world is linked in some way to these markets, when they seize up so do the wheels of commerce worldwide.

So the idea that the grand rescue scheme would instantly cure the financial system has been comprehensively debunked. However, it is wrong to assume that the bail-out has not worked. Medicines always take time to cure a patient, particularly one who has been so shell-shocked by the experience. The money poured into banks has already dramatically improved the credit-worthiness of banks. Investors now bet that it is half as likely that the UK's biggest banks will fail. When this happens it usually precedes a fall in the rate the banks charge each other to borrow - after all, if they are less worried about their counterparts collapsing, they will be more willing to do business with them.

Such changes in sentiment take time to feed through to the rest of the market. When money markets improved earlier this year - before the catastrophic recent relapse - they did so slowly and gradually, and there is little reason to suspect this time should be any different. Having paid £37 billion for bank shares, this may not be the answer the Treasury wants, but it is hard to force banks into lending to each other against their wishes.

The added complication this time around is that although the UK is well through the financial crisis, the economic slump has not yet even gathered pace. In other words, the redundancies, the bankruptcies, the losses associated with the recent turmoil have yet to take their toll on the broader system. Nor has the full force of the biggest housing slump in recorded history been felt.

The UK will not be alone in facing a recession next year. Most experts think that everyone from the US to most European nations to face a slump. However, because of Britain's reliance on the financial services industry it might be more affected than most. As such the Bank of England may be forced to slash interest rates even more sharply than many of its counterparts.